Commercial properties are different from traditional, single-family home investments, which affects the decision-making process of determining which investment is right for you. From considering market dynamics and location, to estimating potential returns and reviewing current occupancy rates, CRE involves factors in those areas that do not necessarily come in to play when investing in residential real estate.[
Whether you are investing on your own or through a passive investment vehicle, such as a REIT (real estate investing trust) or private equity firm, here are some of the factors to consider before investing.
Considering that many commercial real estate investments have low liquidity, having an unclear objective for investing in a property may lead to problems for investors, such as financial distress.
Before purchasing, it is important to determine what your investment goals are, and then find a property or investment that fulfills those goals. You should also consider what you plan to do with the property, including considerations about whether you will invest with the intent to lease it, invest with the intent to sell it, or invest with the intent to develop the property further. Some investors may prefer an owner-occupied strategy, where you plan to occupy the building. In other words, you buy the commercial real estate property and plan to run your own business within it.
Passive investors may still benefit from a plan and an objective for their investments, even though they do not generally purchase the property outright.
Location can play a big role in how your asset performs. Accessibility to major highways, proximity to airports and seaports, and the condition of the area are factors that affect the value of the asset and how much it appreciates over the course of time. Specific, location-based markets may also affect the value.
For example, a location near ports and harbors might be great for tenants who are into manufacturing and exports and imports. Offices near a major highway might be a good choice for tenants who commute to work. Market demand for apartments may also indicate multi-family units are a good investment in a specific city or neighborhood.
When investing in a major urban market, it is important to be cognizant of sub-markets in and around the asset you are interested in. Look for any changes in those sub-markets, such as in demand or supply, that might affect your investment. For example, with the COVID-19 pandemic, some markets saw dips in rental demand for commercial office spaces due to people working from home.
When considering a property’s location, think about the mid-to-long term view of how the area is expected to evolve over the investment period. For example, today’s open land behind an office building could become a manufacturing facility, affecting the value of the pre-existing office building. Also consider reviewing the ownership of nearby properties and their intended usage.
Commercial real estate does not necessarily suffer from the same market shifts as other traditional investment options, such as stocks and bonds. Changes in the market may affect occupancy rates, rental rates, and future demand for the property type.
Keeping an eye on what businesses are stimulating the economy is one way to understand which assets you should consider investing in. In other words, it may benefit you to keep up with commercial real estate trends, research the performance of different types of commercial real estate properties in the current economy, and determine the viability of that sector as an investment.
Cash flow refers to the amount of money that passes through a property. In commercial real estate investing, it refers to the difference between the income and expenses, including debts and other expenditures.
Positive cash flow may indicate a good rate of return. This means more money is flowing from the property to the REIT, private equity firm, or investor. Negative cash flow would mean more money is being put into the property, indicating investors are potentially losing money in trying to maintain the investment.
Consider developing financial projections before investing. This includes considerations for expected cash flow, appreciation, and the benefits of depreciation, or other available tax benefits.
A commercial property’s existing tenants, their financial condition, and their lease terms are some of the factors that can help you determine the viability of an asset for the short- and long-term and if the investment is going to be potentially profitable.
The tenants’ commercial lease terms should be, at the very least, long enough for it to generate some returns. While many leases for commercial properties tend to be long-term, with some exceptions, it may benefit you to check how long each lease agreements lasts. It could range from daily or monthly, such as with multi-family units or hotels, to one year, 3-5 years, or even longer . There are also several different types of leases available for commercial properties, including triple-net, double-net, and single-net leases. This may give you an idea of potential income for a given period of time.
Tenant improvements are also included within lease terms. Depending on the type of lease agreement, tenants may pay for improvements out of pocket or included within their rental payments.
Historical data about lease terms and vacancy will give you an idea of what to be prepared for if you decide to invest. Compare this to available market information on the surrounding area to get a clear and complete picture, along with what the market projects to do, about the property under consideration.
Consider what works best for the performance of the investment: short- or long-term leases. Also consider the terms of the lease. Each lease will be different, depending on factors such as the type of commercial property. Refer to the different types of leases, including triple, double, or single net leases, as well as the gross lease. Learn more about them and see which works best.
When investing, also consider whether new construction or existing properties are the right investment for you.
New construction may offer appealing pricing options, customization options, and modern amenities that older properties might not, prior to purchasing. This all depends on what type of building is being built and to what level it is being built up. Keep in mind that the cost of building has skyrocketed in today’s market.
Consider the replacement cost of the market or location. The replacement cost is the theoretical price you would have to pay to replace an existing asset with a new one at the current market price. This matters because it provides insight into whether it is feasible to build a new property.
You may also benefit from reviewing past projects and researching the construction company’s reputation for any new investments, among other factors. Whether you are an active or passive investor, this is part of the due diligence needed to ensure you are making the right choice for your investment.
Existing properties may offer opportunities for improvements or upgrades, ready-to-lease spaces, and lower cost to purchase depending on the condition of the building and the current market.
If you are determining whether an existing property is right for you, consider monthly maintenance costs, taxes, and other expenses related to the upkeep of an existing building, compared to the same costs for a newly built one.
Before you venture into a commercial real estate investment on your own, you may benefit from having a legal expert take you through all the paperwork to check for any ambiguous clauses or hidden charges, and other issues that you may not be aware of.
You should also review documents such as financial statements for the property from previous owners, a feasibility study, environmental reports, an appraisal, and any other necessary research. For example, if you are planning on developing a vacant property, you should confirm that the zoning will allow you to use the land for the property you intended to build.
If you are opting to work with a REIT or a private equity firm, most of the above factors will be taken care of by the team handling the investment. Do your due diligence on the REIT or private equity firm before choosing to invest with them.
First, what qualifies a commercial property as “a good investment” largely depends on your goals as an investor. There are many ways to measure a property’s success. You may choose to calculate the net operating income (NOI), the capitalization “cap” rate, or even look at past earnings on the property to determine if it has income potential. Every investor has their own risk and reward threshold as well, which will determine whether the investment is a good fit for their portfolio.
Many consider anywhere between 5 – 12% a good return, but again this largely depends on the investor’s financial goals.
Commercial real estate comes with many benefits, including tax deductions and potential passive income. You can learn more about it in our article, Benefits of Investing In Commercial Real Estate.
Capitalization, or cap, rates can vary widely depending on the asset and market conditions where the property is located. They can sit anywhere between 3-10%, but a good cap rate is based more on risk tolerance for a specific investment rather than returns.
With so many factors to consider, it can be overwhelming for an investor, but investing in commercial real estate doesn’t have to be difficult. If you’re looking to get into commercial real estate investments, consider investing through a private equity firm.
Avistone helps you invest in commercial property through equity shares. Investors have the potential to receive distributions through in-place cash flow and capital, preferred returns and capital appreciation upon sales. Our firm also provides the best possible outcomes for our investors by acquiring properties in dynamic markets with proven demand, strong economic indicators, and high occupancy rates.
Contact us to learn more about our current investment offerings.
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